Special message from Mike Percy, Managing Partner, Financial Services
Dear FIEB readers,
I continue to hope this message finds you, your friends, your family, and your colleagues safe. With the second quarter in the rearview mirror, the financial reporting results are unfolding. Initial filings mostly are reporting bleaker earnings, or losses, as compared to the first quarter. We continue to face uncertainty with COVID-19 on many fronts, including whether the recovery will be in the shape, or perhaps shapes, of a V, U, W, or L. Given our resiliency, we will all find our way to a new normal.
As we operate in this continuing unusual environment, we once again have organized this month’s Financial Institutions Executive Briefing to focus on the most critical issues and will strive to keep you updated as events unfold.
Matters of importance from the financial regulators
FDIC issues “Quarterly Banking Profile” for first quarter 2020
The Federal Deposit Insurance Corp. (FDIC) issued, on June 16, 2020, its “Quarterly Banking Profile,” covering the first quarter of 2020. According to the report, FDIC-insured banks and savings associations reported $18.5 billion in net income, down $42.2 billion (69.6%) from a year ago. The decrease in net income was attributable primarily to an increase in provision expenses and goodwill impairment as a result of overall deteriorating economic activity.
The report provides these additional statistics:
- The average net interest margin decreased by 29 basis points from a year ago to 3.13%.
- Community banks earned $4.8 billion during the first quarter, down 20.9% from the same period last year.
- Total loans and leases increased by $442.9 billion (4.2%) from the previous quarter.
- Net charge-offs increased by $1.9 billion (14.9%) from a year ago, and the average net charge-off rate increased slightly from 0.50% to 0.55%.
- From the previous quarter, noncurrent loans (those 90 days or more past due) increased slightly, by 2 basis points to 0.93%.
The total number of FDIC-insured commercial banks and savings associations declined to 5,116 from 5,177 the previous quarter. The number of institutions on the problem bank list was 54, two new banks were chartered, and one bank failed.
NCUA issues first-quarter 2020 performance data
On July 1, 2020, the National Credit Union Administration (NCUA) reported quarterly figures for federally insured credit unions based on call report data submitted to and compiled by the agency for the first quarter of 2020. Highlights include:
- The number of federally insured credit unions declined from 5,335 in the first quarter of 2019 to 5,195 in the same quarter of 2020 (3,255 federal credit unions and 1,940 federally insured, state-chartered credit unions).
- Total assets in federally insured credit unions rose by $132 billion (8.8%) over the year to $1.64 trillion.
- Net income at an annual rate was $8.4 billion, down $5.6 billion, or 40%, from the previous year. The decline is due primarily to an increase in loan and lease loss provisions and credit loss expenses.
- The return on average assets decreased from 95 to 53 basis points compared to a year ago.
- The credit union system’s net worth ratio decreased slightly from 11.13% last year to 11.01%.
OCC’s “Semiannual Risk Perspective” focuses on financial impact from COVID-19
On June 29, 2020, the Office of the Comptroller of the Currency (OCC) released its “Semiannual Risk Perspective” for spring 2020. At the start of the coronavirus pandemic banks were in a strong position, but the quick decline in economic conditions has significantly affected bank earnings, credit quality, operations, and capital. In the report, the OCC recognizes that the federal banking system is experiencing weak financial performance and elevated credit risks, operational risks, and compliance risks.
The report notes increasing credit risk in most industries as a result of volatility in the credit environment from the impact of COVID-19. The OCC identifies some drivers for the increased credit risk including high unemployment levels, risks of default, bankruptcy, dissolution, and new loan relief programs. The OCC further says that flexible and proactive credit risk management practices will be necessary in this environment. Additionally, elevated operational risk continues as banks institute new processes and procedures, address pandemic plans, and respond to rising fraud and cyberrisks.
In addition, the report highlights continued heightened compliance risk resulting from changes in operations as a result of the pandemic and new federal and state programs including the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and the Paycheck Protection Program (PPP), among others. The changes in operations and high volume of PPP applications may result in challenges for complete and accurate operation of bank policies to fulfill Bank Secrecy Act, consumer protection, and fair lending requirements.
FDIC issues final rule regarding deposit insurance assessment
On June 22, 2020, the FDIC issued a final rule to mitigate the deposit insurance assessment impact of participating in the PPP, the Paycheck Protection Program Liquidity Facility (PPPLF), and the Money Market Mutual Fund Liquidity Facility (MMLF).
The final rule removes the effect of PPP lending in calculating the deposit insurance assessment and provides an offset to the total assessment amount for any increase attributable to participation in the PPP and MMLF.
Agencies finalize changes to Volcker rule, modifying “covered funds” restrictions
The FDIC, Federal Reserve Board (Fed), OCC, Securities and Exchange Commission (SEC), and Commodity Futures Trading Commission, on June 25, 2020, finalized proposed changes to the Volcker rule. The changes, which will be effective Oct. 1, 2020, primarily modify restrictions around “covered funds” – hedge funds and private equity funds – to clarify areas of compliance uncertainty that the rule did not intend to restrict. The changes are aimed at facilitating capital formation, protecting safety and soundness and financial stability, and providing greater clarity and certainty about what activities are permitted. The rule also addresses the extraterritorial treatment of certain foreign funds.
Agencies issue statement on managing risks associated with LIBOR transition
On July 1, 2020, the Federal Financial Institutions Examination Council (FFIEC) issued a statement highlighting risks associated with the expected discontinuation of the London Interbank Offered Rate (LIBOR). The risks identified in the statement include:
- Operational difficulty in quantifying exposure
- Financial, valuation, and model risk related to reference rate transition
- Inadequate risk management processes and controls to support transition
- Consumer protection-related risks
- Limited ability of third-party service providers to support operational changes
- Potential litigation and reputational risk arising from reference rate transition
The statement also identifies key steps toward managing these risks, including assessing LIBOR exposure, addressing fallback language in contracts (language about how a discontinued rate will be handled), identifying consumer impact when retail loans include LIBOR references, and evaluating third-party servicer considerations.
In addition, the statement outlines the supervisory focus related to LIBOR for 2020 and 2021.
FinCEN issues guidance on due diligence for hemp businesses
On June 29, 2020, the Financial Crimes Enforcement Network (FinCEN) issued guidance to assist financial institutions in conducting due diligence for hemp-related businesses. The guidance is meant to supplement guidance issued in December 2019.
Due diligence expectations outlined in the guidance include confirming the hemp grower’s compliance with various licensing requirements by obtaining either a written attestation from the customer that it is validly licensed or a copy of the license. Collection of additional information also should be considered based on risk. Such information includes crop inspection or testing reports, license renewals, updated attestations from the business, and correspondence with licensing authorities.
The guidance also includes examples of suspicious activity for hemp-related businesses and information about currency transaction reporting.
Agencies propose revisions to interagency flood insurance FAQ
On June 26, 2020, the FDIC, Fed, OCC, NCUA, and Farm Credit Administration proposed revisions to “Interagency Questions and Answers Regarding Flood Insurance,” which was most recently updated in 2011. The new questions and answers are related to 2015 changes to flood insurance regulations stemming from the Biggert-Waters Flood Insurance Reform Act of 2012 and the Homeowner Flood Insurance Affordability Act of 2014. Specific update areas include escrow for flood insurance premiums, the detached structure exemption, and force-placement procedures.
CFPB proposes rule on escrow exemptions for certain HPMLs
On July 2, 2020, the Consumer Financial Protection Bureau (CFPB) issued a notice of proposed rulemaking (NPRM) to provide a new exemption from the escrow requirement for higher-priced mortgage loans (HPMLs), which typically require an escrow account to be established.
The exemption would apply to HPMLs secured by a first lien on principal dwelling for institutions with $10 billion or less in assets that originated 1,000 or fewer loans secured by a first lien on a principal dwelling in the previous year. Certain other criteria also must be met to qualify for the exemption.
Comments are due within 60 days of publication in the Federal Register.
CFPB proposes two changes to requirements for mortgage loans
On June 22, 2020, the CFPB issued two related NPRMs concerning ability-to-repay and qualified mortgage (QM) requirements for residential mortgage loans under Regulation Z.
The first NPRM would amend Regulation Z to remove the existing 43% debt-to-income ratio as a general QM standard and replace it with a price-based approach. The second NPRM deals with the Government-Sponsored Enterprises Patch (GSE Patch) for Fannie Mae and Freddie Mac loans, which is set to expire in January 2021. The GSE Patch designates a loan as a QM if it is eligible for purchase or guarantee by one of the GSEs, regardless of other factors. The NPRM proposes to extend the expiration date of the GSE Patch until the effective date of the first NPRM, but it ultimately would remove the GSE Patch.
Comments on the first proposed rule, to define a QM with a price-based threshold, are due Sept. 8, 2020. Comments on the second, to extend the GSE Patch, are due Aug. 10, 2020.
CFPB launches advisory opinion program
On June 18, 2020, the CFPB announced a pilot advisory opinion program designed to provide clearer guidance within the regulations under the CFPB’s purview. The program will allow regulated entities to submit requests for clarification where uncertainty exists within a regulation, and the CFPB will select certain topics from these requests and make responses available to the public. Previously, responses to these types of inquiries typically were provided only to the requesting entity. These advisory opinions will be published on the CFPB’s website and in the Federal Register and will serve as official guidance for the particular area of the regulation. Requests for advisory opinions may be submitted via email.
While the pilot program is currently available, comments on the full advisory opinion program must be provided by Aug. 21, 2020.